Central Banks and Monetary Policy
After analyzing monetary policy in both Keynesian and rational expectations paradigms, and across emerging and developed economies, the time has finally come to explore the exact mechanism by which central banks enact monetary growth.
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Central Banks and Monetary Policy
After analyzing monetary policy in both Keynesian and rational expectations paradigms, and across emerging and developed economies, the time has finally come to explore the exact mechanism by which central banks enact monetary growth. We begin by reviewing the institutional structure of major central banks that include the US Federal Reserve (the Fed) and the European Central Bank (ECB). This will be followed by a discussion of the three major methods by which monetary growth, and hence, short-term interest rates are changed. The discussion pertaining to the instruments of monetary policy includes the conventionally accepted (“textbook”) version of changing monetary growth followed by the empirically observed reality of current monetary policy. We then explore and evaluate the objectives of monetary policy in both emerging and developed countries. How should monetary policy be conducted? Sect. 11.3 begins with a discussion of Keynesian stabilization, followed by the Friedmanian x-percent rule, and ends with the Taylor rule. The ECB’s attempts to maintain an inflation target (discussed earlier) will also be revisited in this context. Issues such as the implication and attainment of monetary discipline, and the policy of pegging one’s currency to the hard currency of another country to enable monetary discipline, will be covered towards the end of this chapter. The “impossible trinity”, the undoing of the East Asian economies during the currency crises of 1997–98, Argentina’s 2001–02 crisis, Switzerland’s ordeal in 2015, and the pressures of pegging to a falling US dollar in 2007–08 and then to the rising dollar with the “Taper Tantrum” in 2013, are also discussed in some detail.
© Springer International Publishing Switzerland 2016 F. Langdana, Macroeconomic Policy, Springer Texts in Business and Economics, DOI 10.1007/978-3-319-32854-6_11
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Central Banks and Monetary Policy
Institutional Framework: The Federal Reserve
The Federal Reserve (the Fed), the central bank of the United States, was founded in 1913 by an act of Congress. It should be noted that in the early years of the 20th century, there was strong resistance to the idea of one central bank in the US. However, a series of banking panics culminated in a particularly vicious run on banks in 1907, and this finally led to a consensus for a central bank. The objective (at that time) was to manage the nation’s money supply more effectively and allow it to be more flexible in times of monetary crises.1 The key bodies within the Federal Reserve are the Board of Governors and the Federal Open Market Committee (FOMC). The Board of Governors is based in Washington, D.C., and is composed of seven governors who have non-renewable 14-year terms, staggered by two years. The governors are appointed by the President and confirmed by the Senate. The Chairperson and the Vice Chairperson have renewable 4-year terms, and are both designated by the President and confirmed by the Senate. The fairly long terms serve to insulat
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